Related Party Transactions, Disclosures and Compliances

BY

P. ESWARAMOORTHYCOMPANY SECRETARY IN PRACTICE,7/25, SRI SAKTHI COMPLEX, NANJUNADAPURAM ROAD,RAMANATHAPURAM,COIMBATORE - 641 0450422 - 421690309443419246E-Mail: eswaracs@gmail.comeswaracs@airtelmail.ineswaracs@yahoo.co.in

Presentation Path

• Related Party Transactions

• Need for regulation

• Under the Companies Act – Disclosures and Compliances

• Listing Agreement & Corporate Governance – Disclosures and Compliances

• Indian GAAP – AS 18

• Transfer Pricing Rules

Who is a Related Party ?

According to AS18………

“Parties are considered to be related if at any time during the reporting period one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions ”

AS PER AS 18

Typical Related Party Transaction

Seller Co.Buyer Co. buys Goods from Seller Co.

Mr. Raja owns 60% of Buyer Co. shares

Mr. Raja owns 90% of Seller Co. shares

Mr. Raja

Buyer Co.

Simple transaction (purchase of goods) between two entities (“Buyer” and “Seller”) controlled by the same shareholder (“Mr Raja”), who is on the board of both firms.

Mr Raja is on both sides of the transaction and may benefit if Buyer acquires overpriced equipment from Seller.

Related Party Transactions

• Funded transactions• Intercompany lending and borrowing

• Non-fund based transactions• Fee income for services rendered

• Sharing common resources• Space sharing• Management time for common directors,etc.• Common use of other infrastructure

• Other transactions• Purchase / Sale of goods• Leasing of premises

AS18EXAMPLES OF RELATED PARTY TRANSACTIONS

Need for Regulation• Conglomerates carry on their various business / investment

activities through subsidiaries or associates and acquire interests in other enterprises. This results into multiple legal vehicles and overlapping activities. It also leads to complex business needs and structures

• Arm’s length of transactions and pricing may be at risk resulting into incorrect representation of financial position and operating results

• Due to the above, financials may fail to reflect the correct picture while comparing with previous periods and with other enterprises

• Other issues, viz. revenue leakage for tax authorities, fiduciary nature of relationship with the enterprise, eg. directors,etc.

UNDER THE COMPANIES ACT,1956

• The conduct of directors in respect of contracts or arrangements they are interested is regulated by specific provisions of the companies Act in sections 297, 299, 300 and 301 of the Act.

• As per Section 297 of the Companies Act,1956, Board's sanction to be required for certain contracts in which particular directors are interested.

SECTION 297

• Any Contract with a director of the company or, his relative or a firm in which such a director or relative is a partner, any other partner in such a firm, or a private company of which the director is a member or director for the sale, purchase or supply of any goods, materials or services or for underwriting the subscription of any shares debentures of the company need CONSENT OF THE BOARD IN DULY CONVENED MEETING.

SECTION 297……..

• In the case of a company having a paid-up share capital of not less than rupees one crore, no such contract shall be entered into except with the previous approval of the Central Government.

SECTION 297….• The above provisions shall not affect:• The purchase of goods and materials from the

company, or the sale of goods and materials to the company, by any director, relative, firm, partner or private company as aforesaid for cash at prevailing market prices;

• such contract or contracts do not relate to goods and materials the value of which, or services the cost of which, exceeds five thousand rupees in the aggregate in any year comprised in the period of the contract or contracts

SECTION 297….

• In circumstances of urgent necessity a director or relative, can without obtaining the consent of the Board of directors of the company enter into the contract with the company for the sale or purchase or supply of any goods, materials or services even if the value of goods or cost of such services exceeds five thousand rupees; but in such a case, the consent of the Board shall be obtained at a meeting within three months of the date on which the contract was entered into.

SECTION 297…….

• This section does not apply to contracts between two public limited companies.

• This section is not attracted to a transaction of loan made by a director to the company because it is not a sale or purchase of goods or a contract to render services.

SECTION 297……..

Applicability of this section is to be determined at the time of entering into the contract. If no permission under this section is required at the time of entering into the contract, subsequent permission is not necessary even though there may be a change of circumstances which would require permission to be taken for a fresh contract.

SECTION 297…….• Sale or purchase or lease of immovable

property:• In the absence of any definition of “goods” in

the Act, reference may be made to the definition given under the Sale of Goods Act, 1930 according to which “goods” means every kind of movable property. Thus, for the purpose of this section sale or purchase as also lease of immovable property is outside the scope of the section. However, if the plant and machinery is not permanently attached to the earth, it may fall in the category of goods within the meaning of this section.

SECTION 297….

• Contracts for supply of services included:

• It appears that the section is not designed to apply to appointments of managing directors etc. Contracts under this section include any contracts involving some value. Contract for supply of services are also included. Services do not bear any specific definition though some of their instances can be sited, like banking, finance, insurance, transport, advertising, warehousing ETC

SECTION 297.

• Consequences of non compliance with section:• Section 297 does not provide any penalty for

non compliance, therefore penalty will be as per the provisions of Section 629A of the Act.

• Compounding of offence:• For any default under this section penalty can be

imposed under Sec. 629A and the same is compoundable under Sec 621A.

• Compounding Fees:

SECTION 299• DISCLOSURE OF INTEREST BY

DIRECTORSEvery director of a company who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement, or proposed contract or arrangement, entered into or to be entered into, by or on behalf of the company, shall disclose the nature of his concern or interest at a meeting of the Board of Directors.

• Notice of disclosure should be given by FORM24AA

SECTION 299…

• General notice shall expire at the end of the financial year in which it is given, but may be renewed for further period, of one financial year at a time, by a fresh notice given in the last month of the financial year in which it would otherwise expire.

• EFFECT OF FAILURE TO DICLOSE INTEREST

• Every director who fails to comply with section shall be punishable with fine which may extend to fifty thousand rupees.

• Failure to comply with the requirements of this section will cause vacation of the office of the Director [section 283(1)(i)] and will also subject him to the penalty under subsection

SECTION 299…

SECTION 299.

• Nothing in this section shall apply to any contract or arrangement entered into or to be entered into between two companies where any of the directors of the one company or two or more of them together holds or hold not more than two per cent of the paid-up share capital in the other company .

• The offence is compoundable by Regional Director under s. 621A.

SECTION300

• Interested director not to participate or vote in Board's proceedings

• No director of a company shall, as a director, take any part in the discussion of, or vote on, any contract or arrangement entered into, or to be entered into, by or on behalf of the company, if he is in any way, whether directly or indirectly, concerned or interested in the contract or arrangement; nor shall his presence count for the purpose of forming a quorum at the time of any such discussion or vote; and if he does vote, his vote shall be void.

SECTION 300….• Section shall not apply to:

• a private company which is neither a subsidiary nor a holding company of a public company;

• a private company which is a subsidiary of a public company, in respect of any contract or arrangement entered into, or to be entered into, by the private company with the holding company thereof;

• members holding not more than two per cent of its paid-up share capital

SECGION 301• Register of contracts, companies and firms in which directors

are interested • Every company shall keep one or more registers in which shall be

entered separately particulars of all contracts or arrangements to which section 297 or section 299 applies, including the following particulars to the extent they are applicable in each case, namely:

•  (a) the date of the contract or arrangement;• (b) the names of the parties thereto;• (c) the principal terms and conditions thereof;• (d) in the case of a contract to which section 297 applies or in the

case of a contract or arrangement to which sub-section (2) of section 299 applies, the date on which it was placed before the Board;

• (e) the names of the directors voting for and against the contract or arrangement and the names of those remaining neutral.

Indian GAAP – AS 18• Applicability

• Companies which are listed or are in process of listing• Banks, financial institutions and insurance companies• Enterprises having turnover > Rs. 50 cr.• Enterprises having borrowings > Rs. 10 cr.• Holding / subsidiary company of any of the above

• Related Parties• Holding companies, subsidiaries and fellow subsidiaries• Associates and joint ventures• Individuals (incl. their relatives) – having voting power

giving them control or significant influence• Key management personnel incl.their relatives• Enterprises where controlling individual or key managerial

personnel has significant influence

Indian GAAP – AS 18…contd.

Disclosure requirements

• Related parties• Name and nature of relationship irrespective of

whether or not there have been transactions between them

• Related party transactions• Name of the party and description of the relationship• Volume of transactions• Outstanding balances on balance sheet date• Amounts written off / written back

Indian GAAP – AS 18…contd.

Other Key Points

• Not applicable where confidentiality of data is required as per regulations – eg. banks

• Following are deemed not to be related parties ;• Two companies simply because they have a director

in common (unless the director is able to affect the policies of both companies in their mutual dealings)

• Single customer, supplier,franchiser, distributor or general agent with whom significant volume of business is transacted

AS18

AS18 ……..

LISTING AGREEMENT – CLAUSE 32

Corporate Governance – Clause 49 of the Listing Agreement

WHAT IS ARM’S LENGTH PRICE?

• The "arm's-length price or transfer pricing states that the amount charged by one related party to another for a given product must be the same as if the parties were not related. An arm's-length price for a transaction is therefore what the price of that transaction would be on the open market.

Importance of Arm’s Length Price • The price at which two unrelated and non-desperate

parties would agree to a transaction. This is most often an issue in the case of companies with international operations whose international subsidiaries trade with each other. For such companies, there is often an incentive to reduce overall tax burden by manipulation of inter-company prices. Tax authorities want to insure that the inter-company price is equivalent to an arm's length price, to prevent the loss of tax revenue.

Transfer Pricing Rules• Covered under Direct Taxes• Exhaustive transfer pricing rules introduced in 2001• Deals with computation of income arising from international

transactions between associated enterprises• Discretionary powers to Assessing Officer - if he believes that

less profits have accrued due to international transactions, he can proceed to determine profits using the transfer pricing rules.

• Transfer Pricing Methods• Comparable uncontrolled price method• Resale price method• Cost plus method• Profit split method• Transactional net margin method

AS 18 and Transfer Pricing

AS 18 Transfer Pricing

For significant influence to exist, 20% shareholding is necessary

26% shareholding for applicability of transfer pricing

Parties do not become related merely because one is 100% dependent on the other

These dependent parties will be associated parties for the purpose of transfer pricing

Focuses on disclosure for correct representation of financial statements

Focuses on correct calculation of profits to determine the actual tax payable on them

Applicable for all related parties whether situated locally or abroad

Applicable only for international transactions. Local associates covered under S.40A(2)(b) of Income Tax Act.

• Related Parties

• Directly or indirectly controls, has interest or has joint control over the entity

• Associates of the entity

• Joint ventures

• Key management personnel of entity or its parent

• Close family member of any of the above

• Entities controlled, jointly controlled or significantly influenced / voting power by any of the key management personnel or their close family members

• Entities having post employment benefit plans for the benefits of employees of the entity, or of any of its related parties

International AS – IAS 24

International AS – IAS 24..contd.• Disclosures in financial statements

• Nature of relationship even if there were no transactions between those related parties

• Name of the entities• Compensation of key management personnel

categorised into short-term benefits, post-employment benefits, long-term benefits,termination benefits, equity compensation benefits

• Transactions between related parties• Outstanding balances• Provisions for doubtful debts in respect of related

parties

Thank you